Market Matters

In this edition of Market Matters, Paschke discusses the long-term impact that President-Elect Donald Trump will have on the stock market.

What impact will the election of Donald Trump likely have on the U.S.
economy?

Roger Paschke: Donald Trump has been scant on details so far, but of
the fiscal measures he has been talking about, two key things stand out: tax
cuts for corporations and individuals and a massive $1 trillion of spending to improve
U.S. infrastructure, with the hope of creating more higher-paying jobs along
the way. How much of that spending would come from public vs. private sources
has not been determined. In addition to cutting individual tax rates, he wants
to cut taxes for corporations from 35 percent to 15 percent to encourage more
investment in their businesses (and more hiring), as well as provide a special
tax break for global companies that repatriate corporate earnings back into the
U.S.

There is much debate over whether infrastructure spending
actually boosts the economy in the longer term, although such measures would at
least temporarily create new jobs. However, expansion of corporate businesses
in the U.S. would also create jobs, putting more money in the pockets of
consumers, which presumably they would spend, contributing to increased GDP
growth.

But there is a potential downside. If tax cuts don’t result
in a significant increase in corporate investment (as opposed to just boosting company
stock prices), along with creating jobs, and increasing consumer spending, it could
reduce government tax revenue for key programs, which would add to the U.S.
deficit (the shortfall in U.S. revenue vs. total expense). Also, while Trump
hasn’t said he would increase government borrowing to fund infrastructure, if a
significant portion of this spending ends up coming from the issuance of more debt
that, too, would add to the deficit. Higher deficits generally put pressure on
interest rates and inflation. Rising rates and inflation makes things more
expensive for consumers, which could cause consumers to cut back on spending. Since
consumer spending accounts for about 70 percent of U.S. GDP, the economy
weakens as consumers cut spending.

It’s a delicate balancing act the Trump Administration needs
to engage in if it wants to both cut taxes and increase spending. It could benefit
the economy, in the near term, but depending on the source of the funding, it
could also have an adverse economic impact in the future. Put bluntly, if all
this was easy and obvious to everybody, it would have been done by politicians long
before now.

Donald Trump was elected to be the 45th president of the United States. (Photo: Getty)

Are the financial
markets rallying based on Trump’s policies?

Paschke: In the
early weeks following the election, the U.S. stock market gained about 3
percent. Part of that is due to investors anticipating a better environment for
stocks if Trump’s fiscal policies are enacted. However, investors dislike
uncertainty more than anything else. With the election now over, the
uncertainty over who will be running the government and what policies they will
pursue is no longer hanging over the market. For many investors, it matters
less who won, but just that the outcome has now been determined, and investors
can refocus on the environment for trading stocks.

On the flip side, the bond market has been hit with a major
sell-off since the election. Ten year treasury securities lost nearly 4 percent
in the weeks following the election, while long maturity treasuries lost nearly
8 percent. That’s because the bond market is anticipating higher interest rates
and inflation, if many of Trump’s policies are adopted. So, if you’re a stock
market investor, you might like what Trump’s policies could do for the
corporate environment (e.g. lower taxes, less regulation, etc.). But if you’re
a bond market investor, not so much.

Will Trump’s plans
for infrastructure investments create more jobs?

Paschke: America’s
infrastructure has been in decline for decades, adversely impacting U.S.
competitiveness and costing jobs. Few would argue that major investments aren’t
needed to turn this around. Most studies indicate that new investments in
infrastructure will, at least in the near term, boost economic activity and
create thousands of new jobs. However, not everyone is on the same page as to
what is meant by “infrastructure investment” nor how to pay for it.

It’s not clear whether tax breaks for corporations, which
Trump has proposed, will, by themselves, sufficiently incentivize corporations
to commit significant spending to various infrastructure initiatives in the
areas where it is most needed. As for government resources, Republicans in
Congress have lambasted Obama for eight years over deficit spending to
stimulate the economy and create jobs. So, if part of Trump’s plan is to borrow
more money and increase the government deficit for infrastructure spending,
he’s likely to run into resistance from his own party.

At this point, since we have little idea over how Trump’s infrastructure
plan would actually work, and there is no consensus for what type of plan is
achievable politically, we can’t be certain as to the longer term impact on the
labor market or the economy.

The other major
populist story in 2016 was the Brexit vote in the U.K. How will that impact the
U.K. economy?

Paschke: The most
immediate impact in the U.K. was that the pound dropped to a 30 year low vs.
the U.S. dollar, which means that it is much more expensive for holders of the
pound to buy goods and services in other countries. The U.K. stock market
initially plunged after the Brexit vote, but has since recovered. The U.K. also
lost its AAA credit rating from S&P and Hearst partner Fitch (Moody’s had
early cut the rating in 2013), meaning that the government will pay more to
borrow money. S&P warned of a deterioration in the U.K. economy and less
foreign investment because of Brexit.

To exit, a number of treaties and trade deals with the
European Union (EU) will need to be renegotiated, which is likely to result in
economic relationships with the EU (including tariff-free trading) that are
less advantageous for the U.K.. The biggest potential impact will be whether
the U.K. will be allowed to remain in the EU single market, something the EU
will only accept if the U.K. allows free access for those residing in the EU to
work and live in the U.K. The U.K. wants controls over the number of people
coming into the country from the EU. Overall, the U.K. economy is forecast to
weaken as a result of Brexit. The IMF has cut its forecast for GDP growth in
the U.K. to 1.1 percent for 2017, down from 2.2 percent prior to the vote—the
biggest drop for any country in the IMF forecasts.

Following the Brexit vote, the pound dropped to a 30 year low vs. the U.S. dollar. (Photo: Getty)

Have other
countries that voted for populist leaders or proposals done better
economically?

Paschke: Probably
the clearest example of a populist backlash to tough economic conditions is
Greece. Faced with harsh conditions from the group of Eurozone countries for a
financial bailout to keep the country afloat and remain in the single currency
block of nations, Greece voted in a populist government early 2015. Led by
Alexis Tsipras, the new government, with strong support from the Greek people,
promised to negotiate a far better financial deal with the Eurozone and to end
the stiff fiscal austerity the country was under as the price for remaining in
the euro.

Negotiations in the first half of 2015 were painful,
resulting in banks being closed for several weeks and the introduction of
capital controls. In the end, to receive additional funding and debt relief, Greece
was forced to accept a package of harsh conditions set by Eurozone lenders—even
more severe than the original deal offered up prior to the Tsipras government
coming into power.

Greece’s financial future is still far from secure, and
further bailout negotiations are possible. However, its economy has stabilized at
least for the present and is expected to experience modest growth over the next
couple of years. Populist movements give voice to large components of the
population that have been left out of better economic opportunities. But as in
Greece, these movements clash with the hard financial realities of just how
difficult it is to lift up an economy to the benefit everyone involved.

Cultural Economics

Nationalistic candidates like Donald Trump have appeal in
the U.S. and elsewhere because large portions of the global population have
felt economically disenfranchised. As the economic disparity between high
income people and everyone else significantly widened over the years, the
intensity of the dissatisfaction of the “other 99 percent” has grown
dramatically. Voters across the globe blame this situation on a variety of
factors and conditions, such as trade agreements, immigration, a lack of
infrastructure investments, and tone-deaf politicians, among others.

But whatever the specific circumstances in different
countries, candidates (like Trump in the U.S. or Tsipras in Greece) or issues
(Brexit in the U.K.) have tapped into this dissatisfaction. They’ve had
considerable—and not so surprising—success in capturing people’s attention and
seizing the reins of power. However, gaining the political upper hand and
actually succeeding in addressing people’s deep-seated concerns are two entirely
different things. So, if populist politicians around the world really want to
succeed once their hand is on the tiller (somewhat akin to the barking dog
catching the car), they best stay laser-focused on what got them in power in
the first place. As James Carville, Bill Clinton’s adviser in the 1992
campaign, put it “It’s the economy, stupid.”